The 7 Most Common Mistakes That Lead to Insolvency – And How to Avoid Them
Insolvency is not something that occurs overnight. For many businesses, it is the result of compounding mistakes that snowball over an extended period. Whether your company is in the start-up phase or you’re managing a long-standing company, understanding these issues and how to avoid them can mean the difference between long-term growth and financial collapse.
Below, we highlight the seven most common mistakes that lead to insolvency and how to avoid them.
This is presented as information only and does not constitute legal advice. Each company is different, and accordingly, to receive your tailored advice, please reach out to us on the details below.
Ignoring Cash Flow
One of the most common mistakes that lead to insolvency is mismanagement of cash flow. It is not uncommon to see a business look profitable on paper, but struggle to meet day-to-day obligations like wages, rent, and supplier payments.
How to avoid it: Implementing rolling cash flow forecasts and stress testing for your business to prepare for worst-case scenarios is a great starting point. If this identifies that incoming cash cannot meet outgoings, addressing the gap early is always key. Waiting until company bank accounts are empty will often leave your company with less options.
Overextending Credit and Unmanageable Debt
In terms of business growth, borrowing often plays a large part for many companies; however, excessive reliance on debt, especially short-term or high-interest facility loans, can quickly turn into a ticking time bomb. In the absence of a clear repayment strategy, over-leveraging can occur and often lead to missed payments, default and mounting creditor pressure.
How to avoid it: Always assess your capacity to repay under conservative revenue assumptions before taking on new debt. Always confer with your accountant or financial advisor. Take note of what your business needs to operation, rather than what you want.
Failing to Monitor Financial Performance and Risks
Many businesses operate without real time access to their financial health, which can have detrimental effects on a company’s ability to financially perform. This can often coincide with companies falling behind on tax lodgements and failing to reconcile accounts which can leave directors operating in the dark. Many businesses also fail to consider unforeseeable circumstances, such as being subject to claims without having adequate or proper insurance cover.
How to avoid it: The most affective mechanism of overcoming this mistake is by proactively assessing the financial performance through setting up monthly reporting and using easily accessible accounting tools to track finances. Frequent engagement with accounting professionals can help ensure that financial data is accurate, up to date and on the correct trajectory. It is important for businesses to seek professional advice to ensure they are taking out adequate and proper insurance, as failing to do so could expose them sizeable claims.
Ignoring ATO Debts and Director Penalty Notices
It is not uncommon from companies to view tax debts as problems for another day, until they are knocking on the door. The Australian Tax Office (ATO) are continuously increasing the amount of Director Penalty Notices (DPNs) they are issuing per year. This is leaving directors personally liable for overdue PAYG withholding, GST and superannuation.
How to avoid it: Lodging tax obligations on time is a great first step, even if you cannot pay them immediately. In the event you do receive a DPN, it is important to seek legal advice immediately as these notices attach stringent time limitations and missing them can trigger personal liability.
Trading While Insolvent
In Australia, it is illegal for a company to trade whilst insolvent (or during a period where a director ought to have known it was insolvent). Yet businesses continue to operate in the hope that things will turn around and in doing so often refrain from seeking legal advice. This increases the risk of legal action from creditors and / or liquidators.
How to avoid it: Being aware of the warning signs of insolvent trading is important. These can include trading while the company has an inability to pay its debts as and when they fall due, frequent payment arrangements and being faced with legal threats. The best advice that businesses can receive is that when you face concern, speak to an insolvency practitioner or lawyer early, as this will always provide more options for the company going forward.
Failing to Adapt to Market Changes
A common denominator which leads to insolvency is a failure to adapt to shifting markets and evolving with consumer preferences. Businesses often drift into insolvency as a result of failing to adapt their products, pricing, or business model with progressive consumer demands. This is especially so with the growing reliance on artificial intelligence (AI) and high-cost labour.
How to avoid it: The key is to regularly review your market position, consumer needs, and competitor activity. Businesses that can pivot or refine their offering will often stay relevant. Considering whether your cost structure remains viable in the current climate is a key pillar in avoiding insolvency.
Delaying Professional Advice
The most common mistake business owners make which lead to insolvency is waiting too long to seek advice; whether it be out of pride, denial, or fear. Whatever the reason, by the time the help is sought, options are often limited and the worst case for some becomes unavoidable.
How to avoid it: Seeking legal advice is always a great first step. The earlier you speak to an insolvency professional or lawyer, the more options that are available. These can include, safe harbour protections, informal workouts, voluntary administration or restructuring options.
How We Can Help
Insolvency is rarely a result of a singular bad decision; rather, it is a combination of poor cash flow, insufficient oversight and a failure to act early. The good news is that almost every risk outlined above is avoidable with the right advice and systems in place.
If your business is showing any of the above signs or even if you are looking for a second opinion on your current position, reach out to our insolvency team at Rostron Carlyle Rojas Lawyers for a confidential discussion.
Call us on 07 3009 8444
Visit www.rcrlaw.com.au to book a consultation.
The blog published by Rostron Carlyle Rojas is intended as general information only and is not legal advice on any subject matter. By viewing the blog posts, the reader understands there is no solicitor-client relationship between the reader and the blog published. The blog should not be used as a substitute for legal advice from a legal practitioner, and readers are urged to consult RCR on any legal queries concerning a specific situation.
